Asia's chains that bind

China's foreign trade surged 44 per cent year on year in January 2011 - as production moves up the ladder to high-end products. But other economies are pioneering their own links in Asia's vast manufacturing chains [GALLO/GETTY]

Asian manufacturers have always migrated in search of cheaper labour. Until recently, China seemed their ultimate destination, claiming an ever larger share of investment by Asia's huge production networks. But three developments in China – rising wage inflation, the coming of a new five-year plan that will seek to dramatically shift the Chinese economy's focus from exports to domestic consumption, and a cut-off in the supply of rare earth elements to Japanese companies – may drill significant changes in how these networks invest and function in the years ahead.

Although China is now routinely seen as the workshop of the world, it is Asia's vast and integrated production networks that are the beating heart - not only of Chinese growth, but of economic growth across Asia. Indeed, not long ago, it was thought that many of the production networks that span Asia would move almost all of their manufacturing facilities into China. That trend now appears to be waning.

The key reason is that wages in China began rising much faster than in other low-wage Asian economies, and companies within Asia's production networks are finding it difficult to retain their most talented Chinese staff, particularly in the country's booming coastal regions. Indeed, today, average wages in manufacturing along China's eastern seaboard are higher than in the Philippines and Thailand - countries that once had much higher wages in the export sectors.

China's government responded to this by encouraging manufacturers to move into the country's vast hinterland, where wages are much lower. Yet the farther inland producers went, the less skilled the employees and the higher the costs of transporting goods to market became. Some now argue that, in many sectors, the era of the "China price" – set by exporters who could offer the world's cheapest goods – may be coming to a close.

Of course, no one should write off the strength of China's export machine, even at the cheapest end of production. Like Japan 40 years ago, Chinese production is moving up the ladder to higher value-added products.

Chain reactions

The consequences of rising Chinese wages for China's neighbours are likely to be vast - depending on their current position in manufacturing networks. For those countries that are increasingly competing with China, the challenge is to make their manufacturing more sophisticated or their design more specialised.

Rising wages in China are also creating new opportunities for other regional exporters. Vietnam has already benefited from this, with annual growth exceeding eight per cent in recent years. On the plain between Hanoi and Haiphong, South Korean and Japanese assembly plants sit side-by-side with paddy fields. So potent has Vietnam's growth been over the past decade that the country's economy is overheating.

Bangladesh, too, is starting to join Asia's production chains, which is one reason why it has experienced strong growth since the return to the 2009 premiership of Sheikh Hasina. There, the takeoff point for joining Asia's great production chains was not just the country's low wages, but a decision to redress past government omissions: trade liberalisation, creation of a more favourable investment climate - and infrastructure improvements.

The spread of manufacturing, and hence greater prosperity, into the nooks and corners of Asia's hinterlands through trade and investment flows, points to the need for Asian governments to begin to understand, and reckon with, increased economic integration. Yet, at present, most governments seem to be allergic to reaching agreement on enforceable rules and obligations.

Linking on common ground

Indeed, only crisis seems to concentrate official minds on the need for greater cooperation. In 1998, during the Asian financial crisis, instead of engaging in beggar-thy-neighbour devaluations and financial protectionism, countries found common ground to guard against future crises. The member nations of ASEAN, along with China, Japan, and South Korea, launched a multilateral arrangement of currency swaps - the Chiang Mai Initiative - which pooled members' foreign-exchange reserves in order to help crisis-hit countries suffering liquidity crunches.

Regional and bilateral free-trade agreements have also multiplied since 1998, with even China establishing such an arrangement with ASEAN at the beginning of this year. Today, however, China’s go-it-alone renminbi policy is hitting Asian economies as hard as it is hitting the more vocal United States. Such narrowness of vision cannot continue if Asia's economy is to continue to expand.

Were China to adopt an exchange-rate regime characterised by a multiple-currency, basket-based reference rate with a reasonably wide band, the huge surpluses generated within Asia's production networks would cause the region's currencies to appreciate together, instead of putting pressure on just one or two - as is happening today. Market forces could then allocate these appreciations across supply-chain countries based on their value-added in processing trade. This would not only reduce China's surplus and its need to keep accumulating dollar reserves but also give Asian companies an incentive to reorient production towards domestic markets.

Asia's leaders must move to better insure their countries against the risk of economic dislocation that comes with de facto regional integration. Discussion should start with greater coordination of monetary and fiscal policies, with leaders focusing as much on the regional good as well as individual national interests.

Yuriko Koike, Japan's former Minister of Defence and National Security Advisor, is Chairman of the Executive Council of the Liberal Democratic Party.